ACCOUNTING EARNINGS AND CASH FLOWS AS MEASURES OF FIRM PERFORMANCE - THE ROLE OF ACCOUNTING ACCRUALS

This paper investigates circumstances under which accruals are predict ed to improve earnings' ability to measure firm performance, as reflec ted in stock returns. The importance of accruals is hypothesized to in crease (i) the shorter the performance measurement interval, (ii) the greater the volatility of the firm's working capital requirements and investment and financing activities, and (iii) the longer the firm's o perating cycle. Under each of these circumstances, cash flows are pred icted to suffer more severely from timing and matching problems that r educe their ability to reflect firm performance. The results of empiri cal tests are consistent with these predictions.